How markets workUpdated 3 min readBy the FXNOD team
What is the RSI indicator and how is it used?
The Relative Strength Index, or RSI, is a momentum indicator that compares recent gains with recent losses on a scale from 0 to 100, usually over 14 periods. Readings above 70 are called overbought and below 30 oversold. Those labels describe how strong the recent move has been. They are not instructions to sell or buy.
How it is calculated
RSI takes the average gain and the average loss over the last 14 periods and divides one by the other to get the relative strength, RS. Then RSI equals 100 minus 100 divided by 1 plus RS. If gains and losses have been equal, RS is 1 and RSI is 50. If every period was a gain, RSI approaches 100.
Reading the scale
| Reading | Name | What it tells you |
|---|---|---|
| Above 70 | Overbought | Recent gains have been much larger than losses |
| Around 50 | Neutral | Gains and losses are balanced |
| Below 30 | Oversold | Recent losses have been much larger than gains |
The mistake nearly everyone makes
Overbought does not mean about to fall. In a strong uptrend RSI can sit above 70 for a long time while the price keeps climbing, and selling every reading above 70 means selling into the strongest moves on the chart. The 70 and 30 lines work as reversal hints in a sideways market and as signs of strength in a trending one. Decide which market you are in first.
Three ways it is used
Range trading
In a sideways market, look for turns after RSI goes below 30 or above 70 and comes back.
Trend confirmation
In an uptrend RSI tends to stay between about 40 and 80. A pullback that holds above 40 suggests the trend is intact.
Divergence
The price makes a new high and RSI does not. Momentum is fading, which is a warning, not a timing signal.
Settings
Fourteen periods is the standard. A shorter period, such as 7, swings to the extremes more often and gives more signals, most of them noise. A longer one, such as 21, is smoother and rarely reaches 70 or 30. Some traders move the lines to 80 and 20 in strong trends.
Limits
- RSI is built from past prices only. It cannot know anything the chart does not.
- It works on its own least well. Combine it with trend and levels.
- On a synthetic index it calculates correctly and predicts nothing, because the next move is random.
In FXNOD
RSI is available on the Trade Pilot chart and as an indicator in Bot Forge. A bot that uses it waits until enough candles have formed to calculate a value.
Questions people ask
- What is a good RSI setting?
- The 14-period default suits most uses. Change it only with a reason, and test the change over many trades.
- Should I buy when RSI is below 30?
- Not automatically. In a downtrend RSI can stay below 30 while the price keeps falling. An oversold reading is more useful in a sideways market, and with some sign that the fall has stopped.
- What is RSI divergence?
- When the price makes a higher high but RSI makes a lower high, or the reverse at lows. It shows momentum weakening and can persist for a long time before the price turns.
- Is RSI a leading or a lagging indicator?
- It is calculated from past prices, so it cannot lead them. It is called leading only because it sometimes turns before the price does.
Watch it on a live chart
Open Trade Pilot with your Deriv demo account, pick a market, and see how the price behaves tick by tick, with virtual funds.
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